EVRAZ PLC (LON: EVR) – Leveraging Low-Cost Competitive Advantage to Offset Production Declines

Established in 1992, EVRAZ PLC is a FTSE 100 listed Industrial Metal Mining Company, which has been listed on the London Stock Exchange since 8 June 2005. Primarily, it is operating as a Steel and Mining Company with global operations. The Group has footprints in the United States, Canada, Switzerland, Czech Republic, Russia, and Kazakhstan along with offices in London and Moscow. It is a producer of infrastructure steel products and serves in more than 70 countries. It is operating as a leading player of infrastructure steel in several markets such as American & Russian rail market, Russian beam market, Russian construction market and American LDP market. It operates with over 71,200 employees, while around 94% of employees are in Russian and CIS region. Operationally, the Company produced 13,814 kilo tonnes (KT) of crude steel, 13,230 KT of steel products and 13,765 of iron ore in output in the financial year 2019.

On 29 October 2020, the Company will announce the third-quarter trading update for FY20.


(Source: Presentation, Company Website)
 
Key Fundamental Statistics


Industry Outlook Dynamics

Ever since Covid-19 took hold in Asia and spread worldwide, the restrictions to contain the virus impacted the bulk commodity markets. Therefore, the downturn in steel demand led the hot-rolled coil (HRC) China FOB contracts down by 13% to average US$444/tonne in H1 FY20, as compared to US$510/tonne in H1 FY19. Similarly, metallurgical coal prices hit the level not seen since 2016. However, the strong recovery was seen in June across the markets. During 2019, the Global markets experienced economic and political uncertainties; however, the year was ended at a positive note with a positive trend in prices and steel demand. The consumption trend of steel, iron ore and coal can be seen in the image
below:


(Source: Annual Report, Company Website)

As per the Grand View research report published recently in June 2020, the Global Iron Ore Pallets market is projected to surge by the compounded annual growth rate of 3.70 per cent from 2020 to 2027, which was valued at USD 47.63 billion in 2019. The key factor that will drive market growth is the expansion of steel production in developing economies. Moreover, the growth in construction and automotive industries (being an end-user industry) will play a major role in shaping the industry in future.

Growth Prospects and Risk Assessment

The Company is amongst the top 30 steel producers and top 5 coal producers globally and has maintained a top-notch quality and at a lower cost. The Group sell products to world-class customers, which include big giants from the steel industry. The Company is able to maintain an adequate capital allocation balance between a strong balance sheet, investment for growth and returns to shareholders. It has a well-established internal control system, which helps them to mitigate the risks associated with the working of the Company.

Despite the market turmoil, the Company maintained healthy market shares for key products in Russia in H1 FY20: 40% for structural products, 66% for beams, 68% for rails, and 24% for railway wheels.

 

(Source: Presentation, Company Website)
 
The Group’s ultimate strategic objective is to maintain dominance in infrastructure steel products, while keeping the optimised cost throughout the business. The resilient business model can be understood by the achievement of US$1.1 billion in EBITDA in H1 FY20 despite weakening demand and lower steel, vanadium, and coking coal prices. In H1 FY20, the Company recorded zero fatalities and the long-term injury frequency rate (LTIFR) stayed below the target of 1.60x set by the management for 2020. Further, the Group has taken several initiatives to digitalise sales channels, such as Steel Radar (online platform to track purchase orders), EDI/EDO platform (for handling administrative tasks and exchanging legal documents), and EVRAZ Webshop (e-commerce platform for all types of customers).
 
However, there are certain risks to the business operations as the Company operates in multiple geographies, and thus, profits can be impacted negatively due to the foreign exchange rate fluctuations. Global political uncertainty regarding trade policy also poses a risk for the Group, including protectionist measures and regulation or legislation in local markets.

The Group’s operational performance is exposed to the global macroeconomic environment and industry conditions such as global demand and supply imbalance, which could affect product volumes and prices across all markets. The introduction of new facilities and competitors’ activity in the steel product market could also have a negative impact on the market share of the Company. The Group needs to be adaptive to the changes in market conditions unless it would result in a contract loss and may also impose sanctions by governments. Long production delays and outages could have a material impact on production, operating performance, financial condition.

Also, the total debt has increased by US$229 million in H1 FY20 to US$5,097 million, which has taken the ratio of net debt to LTM (last twelve months) EBITDA to 1.7 times as at 30 June 2020, compared with 1.3 times as at 31 December 2019. The inability to meet the debt obligations can lead to liquidity risk. Moreover, the volatile consumption level of steel and declining prices amid Covid-19 crisis can sharply affect the profitability.
 
A Glimpse of Operating Segments

The Group has bifurcated the business into the following segments:

Steel: This segment comprises the production of steel and related products from locations except for North America operations.

Steel, North America: This segment comprises the production of steel and related products in Canada and the US.

Coal: The Coal segment comprises the operations related to coal production and enrichment.

Other Operations: The Other operating segment comprises companies related to energy, railway, and shipping transportation.

Geographically, the business is differentiated into six divisions, namely Russia, Americas, Asia, Europe, CIS (excl. Russia). Most of the revenue and EBITDA was contributed by Russia operations in FY19.

(Source: Annual Report, Company Website)

Recent Regulatory Updates – Strengthening the Financial Position

19 June 2020: The Group announced a couple of changes in management. It has appointed Andrey Davydov as Vice President and Head of the Coal Division and Leonid Kachur as Adviser to EVRAZ’s CEO.

29April 2020: The Company transferred 4,964,830 ordinary shares out of treasury to the Employee Benefit Trust for no consideration, as a part of Long-Term Incentive Plan.

20March 2020: For general corporate purposes, the Company secured an additional syndicated unsecured credit facility of USD 750 million, which will be maturing in 2025.

Key Shareholders

Progress of Non-Financial KPIs in FY2019


(Source: Annual Report, Company Website)

 
Financial Highlights for the Period H1 FY2020


(Source: Company Website)

On 11 August 2020, the Company provided an unaudited interim result for the six months ended 30 June 2020. In the first half of 2020, the Group’s revenue declined by 18.8% year-on-year to US$4,983 million (H1 FY19: US$6,140 million), mainly driven by lower sales prices for construction, coal products and lower flat-rolled sales volumes, and also reduced prices and volumes for vanadium products. Consolidated EBITDA declined by 2.4% year-on-year to US$1,073 million in H1 FY20 (H1 FY19:  US$1,482 million), bringing the EBITDA margin to 21.6%. The decline in EBITDA was due to lower coal, vanadium and steel product prices, partly offset by a US$251 million effect from cost-cutting and customer focus initiatives. Led by the lower EBITDA and higher capital expenditures, the free cash flow reduced by 54.8% year-on-year to US$315 million in the first half of 2020.

Despite the tough market conditions, the Company was able to generate net profit of $513 million in H1 FY2020, which was significantly up by around 49% against the last year comparatives. Earnings per share also surged massively by around 59% in H1 FY2020.

During the first half of 2020, the net debt surged by US$288 million year-on-year to US$3,733 million (31 December 2019: US$3,445 million). On 30 June 2020, the cash stood at US$1,364 million, while short-term loans and the current portion of long-term loans amounted to US$1,078 million. The Board has declared an interim dividend for 2020 of US$0.20 per share, reflecting the confidence in the Group’s financial position and outlook.

Operational Highlights (H1 FY2020)

In Russia, the sales decreased mainly due to lower demand for wheels and railcar profiles in the second quarter of 2020 amid COVID-19 pandemic. While EVRAZ remained the core supplier to Russian Railways, with sales increased by 7% year-on-year and reached 425kt in H1 FY20 versus 396kt in H1 2019. In Russia, the construction sector was impacted hard by the COVID-19 measures, and demand fell by 17% for beams, 7% for rebar, 14% for wire rod and 21% for structural products (on a year-on-year basis). However, EVRAZ substantially increased the sales to export markets to hedge against fallen demand in Russia. Sales of semi-finished products surged by 17.5% year-on-year in H1 FY20, due to higher slabs sales to the Asian and African markets. The Group managed to extend the order book for semi-finished products which allowed to keep the steelmaking capacity utilisation at the maximum level. EVRAZ further expanded the customer base in Asia, Middle East and North Africa in H1 2020. In the North America region, the combination of the pandemic and the slump in oil prices depressed sales across the business.

Financial Ratios – Improved Profitability in H1 FY2020 versus H1 FY2019

Reported profitability metrics (excluding gross margin) for the first half of the financial year 2020 stood higher than the Industry Median, reflecting higher revenue generated and better control over expenses. EVRAZ Plc has delivered a significant return for the shareholders’ as Return on equity of 39% was higher as compared to the industry median of 2.8%. On the liquidity front, EVRAZ Plc’s current ratio was lower than the industry median, but the Group has sufficient current assets to pay short-term obligations. On leverage front, the debt-equity ratio was 5.57x, which was higher as compared to the industry median.

Share Price Performance Analysis
 

Daily Chart as on 12 August 2020, before the market close (Source: Refinitiv, Thomson Reuters)

On 12 August 2020, at the time of writing (before the market close, at 10:15 AM GMT+1), EVRAZ Plc shares were trading at GBX 347.30, up by 0.58% against the previous day closing price. Stock 52 week High and Low were GBX 575.39 and GBX 200.60, respectively.

Bullish Technical Indicators

From the technical standpoint, the shares were trading well above the short-term support level of 20, 50 and 100-day simple moving average prices, which reflects an upward trend in the stock. MACD line is placed above the central line, indicating a bullish setup. The Company’s stock has delivered a positive return of around 43.32% in the last three months.
 
EVRAZ Plc Vs FTSE 100 Index (3 Months)

 
(Source: Refinitiv, Thomson Reuters)

In the last three months, EVRAZ Plc share price has delivered 36.41% return as compared to the 3.39% return of FTSE 100 index, which shows that the stock has outperformed the index during the last three months.

Valuation Methodology

EV/EBITDA Approach (NTM)

   

*1 US$ = 0.767194 GBP.

To compare EVRAZ Plc with peers, EV/EBITDA multiple has been used. The peers are Polymetal International Plc (EV/NTM EBITDA was 8.43x), Novolipetsk Steel PAO (EV/NTM EBITDA was 6.24x), Severstal’ PAO (EV/NTM EBITDA was 5.87x), Kaz Minerals Plc (EV/NTM EBITDA was 5.81z) and Hill & Smith Holdings Plc (EV/NTM EBITDA was 5.91). The Average of EV/NTM EBITDA of the Company’s peers was 6.45x (approx.).
 
Business Outlook Scenario

In H2 FY20, the Company aims to sustain the production level at full capacity and maximise sales volume in Russia. It also plans to focus on maintaining a selective approach to investment projects and bring additional efficiency improvements. Further, to mitigate this risk for volatile steel prices, the Group is continuously expanding the product portfolio and penetrating new markets. In 2019, the Company increased the coal mining volume by 8 per cent to 94.9 MT (million tonnes), and the US finished steel production grew by 2 per cent to 85.3 MT.  Moreover, the Group has been consistently reducing the cash cost position across steel plants and iron ore products, to stay resilient.


(Source: Presentation, Company Website)
 
EVRAZ in FY2020 will focus on improving safety and other important areas for long-term development. The Company is well-positioned with a sound business model and a decent business growth rate trajectory. The Group expects that the iron and steel market fundamentals would step in the Company's favour in the near term.

The Group has shown an improved financial performance in the first half of the financial year 2020. Despite a decline in revenue, the bottom-line performance has improved. The operational performance was slightly impacted due to disruption in the global supply chain due to covid-19 pandemic. With the improvement in the Chinese economy in the second quarter of the financial year 2020, the Group witnessed an improvement in demand for steel and iron ore in China. Despite an increased demand from China, the Group witnessed a decline in the Russian market and the North American market. The Group is committed to making additional efficiency improvements and will be maintaining a selective and balanced approach to the new investment projects.

Over the course of 4 years (FY15 - FY19), the company's revenue surged from $8,767 million in FY15 to $11,905 million in FY19. Compounded annual growth rate (CAGR) stood at 7.95 per cent.

Based on the decent growth prospects and support from the valuation as done using the above method, we have given a “Buy” recommendation on EVRAZ at the current market price of GBX 343.90 (as on 12 August 2020, before the market close at 8:35 AM GMT+1) with lower double-digit upside potential based on 6.45x EV/NTM EBITDA (approx.) on FY20E EBITDA (approx.).
 
*All forecasted figures and Peer information have been taken from Refinitiv, Thomson Reuters.
*Dividend Yield may vary as per the stock price movement.

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